Despite strong expected demand growth this year, aluminum prices are likely to see a correction to $2,200/mt in London by the end of the year as interest rates rise, making financing deals less attractive, senior analyst William Adams of basemetals.com said Thursday.
Speaking at the 2011 ISRI Convention and Exposition in Los Angeles, Adams noted that much of the aluminum stored in London Metal Exchange warehouses was being held on financing deals.
Those financing deals became more mainstream when commodity prices began to rebound in late 2009 as interest rates fell and banks saw more liquidity. Weakness in the US dollar and concerns about the value of paper assets reinforced the notion of holding base metals to hedge against price volatility, he said. But those deals are now susceptible, he added.
"With inflation on the rise, interest rates are likely to rise before too long, and this might make it difficult for new financing deals, or to roll forward existing financing deals," Adams said. "Therefore, there is a risk that the supply situation could become a bigger, more serious issue."
Aluminum supply grew 49% between 2000 and 2010, he pointed out. As a result, the cumulative market surplus between 2007 and 2010 grew by conservative estimates to 3.7 million mt.
"Production capacity is still rising, as is production itself. So we expect another year of supply surplus this year," he said. Last year, the global aluminum market was estimated to be in surplus by about 577,000 mt, according to estimates by the World Bureau of Metal Statistics.
This year, aluminum production is expected to grow 8%. The excess production has resulted in exchange stocks totaling nearly 7.4 million mt, with another 3 million to 4 million mt thought to be held in private warehouses.
Current aluminum stocks are sufficient to satisfy global demand for 38 days, compared with just six days for copper, Adams said.
Financing deals have absorbed much of the excess production, and have therefore helped keep aluminum prices high, despite the market surplus and rising stocks. "Without financing deals, metals prices would undoubtedly be lower," he said.
The absorption of excess aluminum into storage through financing deals meant that producers could continue to produce, knowing that much of their production would never reach the market and push down prices, Adams said.
"In many ways, what we are seeing is an aberration, a consequence of circumstances. But the fact is that financing deals exist, and while they do, a surplus is likely to hang over the market," he added.
But rising interest rates, and the end of quantitative easing programs by central banks are likely to decrease the attractiveness of financing deals, he said.
SUPPLY, NOT DEMAND DEFINES ALUMINUM GROWTH
Turning to demand, Adams said aluminum demand rose nearly 60% between 2000 and 2010, for an annual composite growth of 4.8%. In 2011, aluminum demand is expected to grow 7.5%.
Growth was boosted last year by restocking and the substitution of primary aluminum for scrap as scrap generation lagged demand, he said. But the long-term outlook for aluminum demand remains bright, with per capita consumption in developed countries expected to be 20 kg/year, but only 1 kg/year in India and 5 kg/year in Brazil and Indonesia, and 12 kg/year in China.
The damage from earthquakes and tsunamis in Japan is likely to dent consumption initially due to the destruction of the supply chain, Adams said, though lost consumption in the short term might be made up later.
"The situation at present is one of strong demand growth, but there are areas of concern. I don't think the story of aluminum is one of demand; it's really a supply story," he said.
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